Operational Framework for Reclassification of FPI into FDI

As per Schedule II appended to the FEMA (Non-Debt Instrument) Rules, 2019, Foreign portfolio investors (FPIs), are required to ensure their investment remains below 10% of a company’s total paid-up equity capital. Generally, if this limit is breached, FPIs are mandated to either divest their holdings or reclassify them as foreign direct investment (FDI) within five trading days from the date of settlement of the trades causing the breach of the prescribed threshold. An operational framework for this reclassification was released by the RBI on November 11, 2024.

Process for Reclassification

1. Prior Approvals: Foreign portfolio investors (FPIs) intending to acquire equity instruments beyond the prescribed limit must obtain:
   1. Government Approvals: Necessary clearances, including those for investments from bordering countries, and ensure compliance with FDI rules such as entry routes, sectoral caps, investment limits, pricing guidelines etc.
   2. Indian Company’s Concurrence: Agreement from the Indian investee company to reclassify the investment as FDI, enabling the company to comply with FDI-related restrictions, sectoral caps, and required government approvals.
2. Disclosure and Timeframe: An FPI intending to reclassify its existing investment as FDI must declare its intent and provide necessary approvals and concurrence to its Custodian. The custodian will then freeze the FPI’s purchase transactions in the company’s equity instruments until the reclassification is complete. If the required approvals or concurrence are not obtained, the FPI must divest any investment exceeding the prescribed limit within the stipulated timeframe. For reclassification, the entire investment held by such FPI shall be reported under Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019, in the following manner:
   1. By the Indian company in form FC-GPR where the investment beyond the prescribed limit is resulting from fresh issuance of equity instruments by an Indian company to such FPI.
   2. By the FPI in form FC-TRS, where the investment beyond the prescribed limit is due to acquisition of equity instruments by such FPI in the secondary market.
   3. AD bank concerned shall report the amount of reclassified foreign portfolio investment as divestment under the LEC (FII) reporting.
3. Transfer of Equity: After completing the required reporting, the FPI must request its custodian to transfer the equity instruments from its demat account for foreign portfolio investments to its demat account for FDI. Once the reporting is verified, the custodian will unfreeze the instruments and process the transfer. The date of the investment causing the breach will be treated as the reclassification date. Thereafter, the FPI’s entire investment in the company will be classified and remain as FDI, even if it later drops below 10%. Post reclassification of foreign portfolio investment to FDI, the said investment shall be governed by Schedule I to the Rules.
4. Exclusions: As per the current FDI Policy, the following sectors are not allowed to receive FDI. Thus it necessarily follows that investors operating in such sectors will not be allowed to reclassify – Gambling and Betting; Lottery business; activities /sectors not open to private sector investment; retails trading; chit fund; Nidhi company; Real estate business or construction of farm houses; Trading in transferable development rights; Manufacturing of tobacco, cigars, cheroots, cigarettes and other tobacco substitutes; agriculture (excluding floriculture, horticulture, apiculture and cultivation of vegetables and mushrooms under controlled conditions, the development and production of seeds & planting materials, animals husbandry including the breeding of dogs, viniculture & aquaculture under controlled conditions and services related to the agro and allied sector)

Concurrence with SEBI

The RBI Circular concurs with the SEBI Circular dated November 11, 2024 which also provides for the procedure for reclassification of FPI investment to FDI. The Circular provides the same guidelines as the RBI Circular and can be accessed here.

Conclusion

RBI’s operational framework is a welcome step as it has been introduced to simplify and standardize the process of reclassifying foreign portfolio investments (FPI) into foreign direct investment (FDI). This framework aims to provide clear guidelines for FPIs and Indian listed companies, ensuring that the transition is smooth and adheres to the Non-Debt Instrument (NDI) Rules.